New Law Offers Break For Small Businesses

YOUR MONEY - TAXES

Some recent changes in the tax law will help owners of small businesses who are concerned about estate taxes.

A key revision is a gradual boost in the amount of assets exempt from estate and gift taxes.

The exemption is $675,000 for individuals who die in 2000 or 2001 and is scheduled to further increase in uneven spurts until it reaches the $1-million mark for 2006 and later years.

The intervening exemptions are $700,000 for 2002 and 2003, $850,000 for 2004, and $950,000 for 2005.

The law further trims estate taxes for married couples with a marital deduction that generally allows unlimited transfers of property from one spouse to another.

Consequently, all assets in excess of the exemption amount that are left to a surviving spouse who is a U.S. citizen are shielded from estate taxes by the marital deduction.

Another important change that went on the books at the start of 1998 is a first-ever deduction (in addition to the exemption) for owners of small businesses.

By 2006, the amount that can be left free of estate taxes will be a combined total of $1,300,000 -- exemption of $1,000,000 and deduction of $300,000.

The new deduction treats small businesses and family farms as a separate class of assets.

This creates a significant break for their owners, compared with less-deserving folks who work for salaries or amass portfolios of mutual funds, publicly traded stocks and bonds.

Despite the hype, keep the bubbly corked. The deduction is riddled with eligibility-limiting technicalities that makes it unavailable to most owners, though the new possibilities will generate lots of work for attorneys and accountants who do estate planning.

That is assuming the entire value of the owners' estates exceeds the $1,000,000 exemption.

One barrier is that the business must be worth more than 50 percent of the estate's total assets.

If nonbusiness assets are slightly too high, all that owners need to do to maneuver around that limitation is to make gifts that diminish their value.

Other problems are complex ownership and participation requirements.

For example, family members or other qualifying heirs must have owned and materially participated in the business for at least five years during the eight-year period prior to the owner's death.

Also, they must continue for at least five years during any eight-year period within 10 years after.

What if they sell the business within the proscribed period of 10 years after the owner's death?

A disqualifying sale triggers recapture by the IRS of the estate taxes that were avoided, plus interest.

Just how much the feds recapture depends on when the disqualification occurs.

The deduction provision was crafted to help keep the business in the family and pass it on to the next generation.

The 1997 overhaul of the Internal Revenue Code encourages exactly the opposite with its decrease in the top rate for most long-term capital gains from 28 percent to 20 percent, which creates an incentive to sell the business.

And there is sentiment in an election-year, Republican-controlled Congress to further reduce that top rate, though the Clinton administration thinks otherwise. Stay tuned.